Buch: Completing banking union secures financial stability
ECB Supervisory Board Chair Claudia Buch emphasized the need to complete the banking union to secure progress made in weakening the bank-sovereign nexus. Speaking at a conference in Frankfurt, she highlighted the importance of strong regulation and resolution powers.
Reforms paid off, but vigilance needed
Buch highlighted that post-crisis reforms have significantly weakened the bank-sovereign nexus, which is no longer a primary prudential concern.
This progress stems from stronger regulation, supervision, and resolution powers, moving from bailouts to bail-ins.
Additionally, bank balance sheets have substantially strengthened over the past decade, with improved asset quality and higher capitalisation.
Looking ahead, Buch emphasized two crucial safeguards: maintaining and strengthening the institutional framework, including completing the banking union and establishing a European deposit insurance scheme.
The second safeguard is the continued resilience of the banking sector itself, especially given the challenging geopolitical risk environment.
She noted that while vulnerabilities are less country-specific now, fiscal space may be tighter, requiring banks to rely on their own strength.
Sovereign bonds and fiscal backstops
Buch detailed how banks and sovereigns are linked, primarily through bank holdings of government bonds, which serve as liquidity buffers and collateral.
Euro area bank holdings of government bonds remain stable relative to total assets at 9.3%, with the ratio to CET1 capital decreasing to 170% due to improved capitalisation.
The home bias in sovereign bond portfolios has also declined from 39% in 2014 to 28% at the end of 2025.
However, the Silicon Valley Bank episode in March 2023 reminded that even high-quality assets can become a source of stress if market values fall and confidence is lost.
Another link is through loans to households and firms, where fiscal support during the COVID-19 pandemic and energy crisis provided ex-post insurance, reducing credit risk for banks but embedding contingent liabilities for sovereigns.
This means banks' risk models must adjust for altered historical correlations between macroeconomic stress and loan losses.
A fragile equilibrium
Buch's speech underscores a critical, yet often overlooked, aspect of European financial stability: the ongoing need to fortify the banking union.
While significant progress has been made, the intertwining of bank and sovereign balance sheets remains a structural vulnerability, particularly as new geopolitical risks emerge.
Completing the banking union is not merely a technical exercise; it is a fundamental step towards ensuring the resilience of the financial system against future, unpredictable shocks.